Is The European Central Bank Waiting for Another Crisis to Erupt?

Market Trends - 28/09/2016

Europe’s lacklustre growth and rising unemployment has strengthened calls for a grand bargain to relax fiscal policy and tighten the ECB’s monetary stance. Nevertheless, the odds of that happening are fast diminishing amid the complex political constraints that grip the region.  Europe is trapped between the devil and the deep sea. Ending the ECB’s easy money policies could unleash financial turmoil. Yet by continuing with them, the economic and political fragmentation of the bloc will only grow as time passes. The heady cocktail of negative rates and quantitative easing is hurting the lending capabilities of banks, destroying pension fund returns, and ultimately eroding the Central Bank’s credibility. One need look no further than the downturn in Deutsche Bank for evidence of a looming calamity.  Time is running out, and before another crisis erupts, ECB President Mario Draghi needs to enforce a Euro-wide tightening of monetary policy, while simultaneously loosening the tight fiscal grip.

 

What is preventing Draghi from acting is the growing political uncertainty in key member states. The support base of anti-establishment parties is growing – an indicator of the overall disillusionment with policies of the monetary union. The top five economies — Germany, France, Spain, Italy and the Netherlands — all have major elections coming up in the next 12 months. The voices that forced the UK to opt out of the European Union will surely replay in those countries.  Due to lack of any complementary support from governments, tapering the ECB’s asset purchases or raising rates might spark a market selloff, making these moves highly unlikely.  While various committees at ECB are working at models to possibly extend the QE beyond March 2017, the issue is of a declining pool of available assets. A decision on that front will not arrive before December. However, whatever the outcome, considering the complexity of the situation in Europe, any measure will be controversial.

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